A Netflix-Subscription-Like Electricity Bill

Everything about electricity rate design is on the brink of a complete remodeling

Photo by Nuno Marques on Unsplash

The Problem

The mounting levels of behind the meter rooftop solar generation are swiftly tousling the current utility revenue model. Prosumers (customers with rooftop solar are usually referred to as prosumers: producers+consumers) under net energy metering (you sell your excess power to utility with the same purchasing price) are simply scoring a lot of bill savings, which adds more burdens on utilities to recover their considerable fixed costs. The reduction in prosumers total consumption does not proportionally reduce the cost to serve them. This misalignment pushed many utilities to thoroughly revise their metering policies and rate designs (see here).

The Switcheroo In The Retail Electricity Market

In California, a state that leads solar industry (see here), the severity of the utility revenue shortfall due to onsite generation is way more than any other state. This is mainly signaled by the reliance of many investor owned utilities (IOUs) in California on a one-part tariff (volumetric charge) to collect money. The myopic one-part tariff has created a large price markup (the price markup here is the difference between retail and wholesale prices), which only increases the achieved bill savings by prosumers. To get a sense on how bad the situation is, the average electricity retail price in California is currently among the highest in the US, and it is triple the wholesale price (see here).

The higher the electricity price markup, the more bill savings prosumers achieve, and the more bill payment regular consumers face.

The Solution

So how can we fix this utility revenue shortfall problem ? There are several and completely different methods to approach balancing bill savings, with a tradeoff in every method.

Frank P. Ramsey (source: Cambridge Wittgenstein archive)

However in this context, I will focus on the so-called Ramsey Pricing to relax the price markup and hence the unfairly high bill savings achieved by prosumers. It will also become clear how this pricing is very similar to what you pay for your Netflix subscription.

Ditching the one-part tariff, which is mathematically proven to be regressive under net energy metering, the two-part tariff, as its name indicates, rely on two different parts to accrue money. The first part is a volumetric charge (what you consume multiplied by the rate), and the second part is a fixed charge that is independent of the consumption.

Under Ramsey pricing with two-part tariff, the utility sets its retail price almost equal to the wholesale price (3~4 cents/kWh) and relies on the fixed charge part to recover most of its costs. The electricity bill under this tairff will become very similar to what you pay for your Netflix subscription, which is a fixed payment independent on how many movies or series you watch. The consideration of Ramsey two-part tariff has two direct advantages to utilities:

1. The revenue is less stochastic. Contrary to volumetric charges, customers, even rational ones, have no way of avoiding fixed charges. This contributes to the stability of the revenue.
2. The issue of revenue shortfall and cost shifts is minimized. The reduction of the price markup (which is almost zero under Ramsey two-part pricing) directly curtails the bill savings achieved by prosumers, which in turn elongates the payback time on their rooftop solar investment.

The Drawbacks

Although Ramsey two-part pricing is very appealing to utilities, especially those on the brink of bankruptcy, the tariff comes with significant drawback to the electricity industry and the environment.

1. The reliance on fixed charges to achieve revenue at the cost of diminishing dependency on volumetric charges, impacts energy efficiency and rational usage. Higher percentage of the consumer bill will be independent of their consumption, which induce the tendency of irrational over-consumption due to the lack of incentivization.
2. The adoption of rooftop solar will be stalled or at least severely affected. The consumer’s adoption decisions are mainly driven by the bill savings they can achieve and therefore systems’ payback time, which is very long given the small price markup.

Lastly, the journey of rate making is just starting, and I hope consumers have time to buckle up, before utilities say it is too late.